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Time to Put Benjamins Back in the Sock Drawer?

Posted on October 31, 2019 by -

Last Monday, two days before Federal Reserve chair Jerome H. Powell would announce this year’s third quarter-point reduction in the fed funds rate, MIT economist James Poterba was delivering a presentation in the Sheraton Boston on the headwinds that low rates create for middle-class retirement savers.

Poterba was one of the first speakers on the first day of the annual conference of LIMRA, the organization that conducts research for its member life insurance companies. He prefaced his remarks with a spoiler-alert that no one in the room—after a decade of historically low rates—especially needed.

James Poterba

“We’re in a much tougher environment for the provision of savings for retirement today, both in terms of the capacity to save and the capacity to turn savings into retirement income,” said Poterba, who is also president of the National Bureau of Economic Research. “What I have to say will be a little depressing.”

The audience was duly attentive. Life insurance companies earn their money by investing their customers’ premiums—trillions of dollars, collectively—mainly in bonds and other fixed income securities. When the Fed pushes down 10-year Treasury rates, as it did from 2009 to 2015, it squeezes their earnings and reduces the benefits they can pay.

More recently, the Fed has whipsawed insurers. Starting in December 2015, it raised the fed funds rate (the rate at which banks lend reserves to each other at the Fed) in nine quarter-point increments, to between 2.25% and 2.50%. But this year, after President Trump criticized the tightening policy for hurting the economy and the stock market (and his reelection chances), the Fed reversed course and reduced rates in three quarter-point increments, to between 1.5% and 1.75%. So Poterba’s presentation, if not uplifting, was timely.

How low are rates?

Since 2010, U.S. savers have been better off hiding Benjamins in the sock drawer than buying 10-year Treasuries. In 1990, the nominal rate was 8.48% and real after-tax yield was between 1.25% and 1.66%, depending on your tax bracket. By 2010, the real after-tax yield dropped to between -10 and -20 basis points. Prior to this week’s reduction, it was about -40 basis points.

“Over the many years I’ve taught intermediate macroeconomics, the real interest rate has always been positive,” Poterba said. “[But with rates falling so low], at what point do savers decide that currency dominates other financial instruments. Apple may decide to create a secure facility where their money will yield zero but will be safe. One of the reasons for going to a cashless society is that cash becomes a problem if the government wants to run a negative interest rate.”

Yet U.S. benchmark yields are higher than in many European countries. The yield on inflation-indexed government bonds in mid-October was 55 basis points in Canada and 28 basis points in the U.S. It was -200 basis points in Sweden and -231 basis points in the United Kingdom.

Low rates hurt mass-affluent households the most, Poterba said. “For the 20% to 40% of the population without much savings, and for the 20% with the most savings”—more than enough to retire on—“[low rates] won’t matter much,” he said. “It will mainly affect the middle group who used to depend on a combination of defined benefit pensions and private savings. They rely most on the rate of return to fund their retirements.”

All else being equal, low real rates require people to save more for a longer period to create a nest egg that will generate enough income in retirement to replace an adequate share of their final salary and allow them to maintain their standard of living after they stop working.

For instance, if you assume that a person save a real 1% of their salary per year and their salary increases by a real 1% per year, it will take considerably longer to replace one’s final salary at low risk when the real risk-free rate is 3% than when it is 1% or zero. The table below indicates that it would take about 20 years to replace about a quarter of one’s final salary by saving at 3%, but about 30 years to replace that amount with a 0% return.

Falling interest rates hurt younger people, who have yet to buy assets like homes and bonds, Poterba said, and help older people whose assets increase in value when rates go down.

“The long Treasury market has been the best asset for performance this year,” Poterba said. “If you already owned bonds and got the big capital gains, you did wonderfully. You’re much richer than you were last year. But younger people who buy new bonds will get a tiny rate of return” and not much chance of capital gains in the future because rates can’t drop much farther.

But low rates also impact older people who might otherwise buy annuities. Low rates depress the payout rates offered by single-premium income annuities, which makes them less attractive. In 1987, when AAA-rated corporate bonds paid between 9% and 10%, an annuity for a 65-year-old man paid out about $1,000 a month. At today’s rates, the payouts are less than $550 a month.

What to do about it?

To offset the impact of low yields on savings, Americans will have to save more, work longer, take more risk with their investments, inherit money from their parents, or live with their children in their old age, Poterba said. Working longer is the most reliable solution, he noted, because it can both increase savings and reduce the number of years spent in retirement.

As for investing in stocks instead of bonds, Poterba didn’t list that as one of his recommended remedies for low rates. The conventional wisdom is that low rates encourage investors to buy stocks or stay in stocks; but Poterba said that, unless you think the equity premium (the historical return advantage of stocks over bonds) will grow, then lower interest rates harbinger lower stock returns in the future.

“The expected real rate of return for stocks over the next ten years has fallen from 6.5% in 1996 to between 3.0% and 3.5% today,” he said. “So the expected returns on stocks have drifted down along with the interest rate, assuming that the risk premium stays constant.”

© 2019 RIJ Publishing LLC. All rights reserved.

Lessons of Past Intra-Government Investigations

Posted on October 31, 2019 by -

Recent stories in the news raise important questions about the ability of government to impose constraints on abusive government investigations.

I’m not here to judge the credibility of the allegations that President Trump used his office to encourage foreign governments to investigate Joe Biden’s son or that a Treasury Department official interfered with audits of the President’s or Vice-President’s tax returns.

Instead I want to turn to the history of the IRS to draw out important lessons in how issues such as these have been addressed in the past and then use that information as a base from which Congress can consider further guardrails to prevent future abuses. Among the possibilities are to further require, not simply offer protection for, whistle blowing.

The first line of defense, of course, is the integrity of public officials themselves and the norms they help create. More than four decades ago, White House Counsel John Dean gave IRS Commissioner Jonnie Mac Walters a copy of President Richard Nixon’s “enemies list” that included about 200 Democrats whose tax returns he wanted audited. Walters and Treasury Secretary George Schultz agreed between themselves to throw the list into a safe and forget about it.

When Walter’s successor, Donald Alexander, discovered that a handful of IRS staffers had been assigned to investigate the returns of about 3,000 groups and 8,000 individuals, often because of their political views, he disbanded the group. Those of us who knew him are aware of how proud he was for standing up to the White House and protecting the integrity of the IRS.

Interestingly, it wasn’t until 1998 that Congress turned this normative prohibition into law. The Taxpayer Bill of Rights, part of a bill that restructured the IRS that largely came out of a Republican-led Senate, said this:

It shall be unlawful for any applicable person to request, directly or indirectly, any officer or employee of the Internal Revenue Service to conduct or terminate an audit or other investigation of any particular taxpayer with respect to the tax liability of the taxpayer.

Congress said applicable persons include the President, Vice President, and any employee of the White House and most Cabinet-level appointees.

The Taxpayer Bill of Rights made clear that Congress was concerned about protecting potential victims, not just punishing offenders. Each individual is entitled to equal justice under the law, and Congress determined that politically motivated investigations violated that justice standard. The Joint Committee on Taxation staff in their explanation of the law listed another reason: The concern that improper executive branch influence could have a “negative influence on taxpayers’ view of the tax system.”

The 1998 law not only prohibited this improper influence, it explicitly required disclosure:

Any officer or employee of the Internal Revenue Service receiving any request prohibited by subsection (a) shall report the receipt of such request to the Treasury Inspector General for Tax Administration.

It says “shall.” Disclosure is not optional. Congress made it a crime for “any person or employee of the IRS receiving any request” to fail to report it, whether it was direct or indirect. No explicit quid pro quo necessary to get the Inspector General involved.

In the current context, the statute is clear: Anyone in the IRS, including the Commissioner, must report any improper attempt by high-level executive branch officials at interfering with audits of the president and vice-president or anyone else.

Thus, there are at least five bulwarks against inappropriate political interference with IRS investigations.

Appointment of professionals and strong leaders who will protect the integrity of their offices;

Social norms that most politicians would feel reluctant to violate;

Penalties on those who interfere in the investigative process;

A requirement that those receiving the unlawful request report it;

Penalties on those who fail to report the request (to go along with the penalties on the requestor).

No law is perfect, and a president or other person could find their way around current law or protect others who abuse it. Still, norms and laws do constrain the quantity and extent of bad actions. So does a transparent disclosure system for revealing abuses. Even if some figure out how to violate legitimate boundaries, fences still can limit trespassing.

As citizens, and taxpayers, we all have rights to equal justice. Enforcing those rights often requires laws, as well as norms. The development of law protecting taxpayers against abuses of the IRS audit process may set an example for Congress to apply to elected officials, officers, and employees beyond the IRS and to investigations undertaken by other agencies.

This article was first published in the TaxVox blog at taxpolicycenter.org. 

Kindur, a young robo-advice firm, is growing up

Posted on October 24, 2019 by -

Kindur, a robo-advice startup based in New York, has introduced SmartDraw, an automated service that creates retirement income streams by withdrawing funds from multiple retirement accounts tax-efficiently, Kindur founder and CEO Rhian Horgan said this week.

No matter how much they’ve saved or how financially-literate they are, many baby boomers are expected to be perplexed and daunted by the number of decisions about Social Security, Medicare, and required distributions from retirement accounts that they will face at retirement or soon after.

Rhian Horgan

Even as a relatively late arrival in the fintech market, Horgan still sees ample opportunity there. “When the stakes are this high, customers need to move past using rules of thumb and make sure they are creating a retirement income plan that specifically addresses their circumstances,” Horgan told RIJ this week. (See our December 2018 article about Kindur.)

The SmartDraw service is available for a subscription fee to Kindur clients, whether they have savings under Kindur’s management or not. There are three service levels: Select ($99/year), Premium ($149.99/year), and Concierge ($299.99/year) packages that may include:

  • Automated Withdrawal Recommendations. This service helps customers minimize taxes by analyzing their retirement accounts and spending needs and delivers recommendations on which account to make withdrawals from first.
  • Automated RMD Calculations. The system reports customers’ annual required minimum distributions from tax-deferred accounts, starting the year after the year in which they reach age 70½. The service is intended to help clients avoid the potential tax penalty of 50% of any unpaid RMD.
  • Medicare Surcharge Concierge Service. This handles the filing of high income customers’ Medicare surcharges. If the clients experience a sharp reduction of income, the service will make sure their Medicare premium shrinks accordingly.
  • Federal and State IRA Withholding Strategy. This helps customers avoid tax penalties and high year-end tax bills by recommending the right monthly withholding strategy for state and federal taxes when one makes withdrawals from their IRA accounts.
  • Access to a licensed financial adviser. The adviser will create a custom plan for each retiree.

For a household with $1 million in savings, SmartDraw could save as much as $61,000 over the course of retirement, a Kindur release said.

“Our software runs five different withdrawal strategies,” she told RIJ. “We take in the client’s age, the spouse’s age, filing status, federal and state tax rates, and look at where their assets are held. Then our software runs five different withdrawal strategies.

“The first strategy is taxable money out first, then tax-deferred, then tax-exempt,” she added. “The second is taxable money out first, then tax-exempt, then tax-deferred. We also run three variations of tax bracket management where we measured amounts from each type of account. We’ve found that, for someone with $1 million, the difference between the best and worst strategies is about $61,000 over the retirement period.”

“We have about 10,000 users who have created retirement plans with us or engaged with our calculator, and we’ve created $5 billion worth of retirement plans,” Horgan told RIJ this week. “We’ll release new growth numbers next year when we’ve been live for a year. We also expect another round of financing in 2020.”

Private equity investors don’t have as steep a learning curve as they once did, she said. “Three years ago, we had to explain to a lot of investors,” Horgan added. “We had to show what the [retirement] opportunity set was. Today the investor community understands it. An ecosystem is building that recognizes the opportunity to bring technology to the [boomer retirement] challenge.”

Kindur’s core technology is homegrown. “We’ve built all our own software rather than buy it,” Horgan said. “We found that most software is built for one narrow task or another. We also found that a lot of software is designed for advisers, not for the average human. Our core value is to be human in a world that often just sees numbers.”

© 2019 RIJ Publishing LLC. All rights reserved.

Pitching Income Annuities on Greed

Posted on October 24, 2019 by -

“Longevity” was the theme of the combined Financial Planning Association (FPA) and Academy of Financial Services 2019 annual conference last week. Some 1,800 Continuing Education credit-hungry advisers convened in Minneapolis to receive wisdom from some of the heavy-hitters of the retirement income space.

Wade Pfau, Ph.D., of The American College, was there to talk about the most popular types of annuities and about life insurance in retirement. David Blanchett of Morningstar, Curtis Cloke of Thrive Income, and Social Security expert Bill Reichenstein all presented their work.

A paper evaluating three approaches to “bucketing,” co-authored by Harold Evensky, was showcased. Retirement gurus Bob Laura and Bob Mauterstock discussed emotional aspects of investing and retirement. Yi Liu and Michael Guillemette presented a paper, “Does Risk Aversion Influence Annuity Market Participation.” (Yes, it does.)

Pfau, who is director of the Retirement Income Certified Professional program at The American College, offered FPA members a 45-minute tutorial on the three main types of annuities: income annuities, variable annuities and index annuities. Pfau has just published “Safety-First Retirement Planning,” a book that describes the synergies that can arise from combining annuities and mutual funds or exchange-traded funds.

In one of his examples, he showed that a life-contingent immediate annuity for a 65-year-old woman could produce $10,000 per year for life for about $172,915 at current rates. Using the 4% safe withdrawal percentage rule, $172,915 in savings would initially produce annual income of about $6,920.

Pfau also compared the annuity with a bond ladder. A 35-year ladder of risk-free zero-coupon bonds producing a safe $10,000 per year for 35 years would cost about $224,872.

Retirees could in theory buy the annuity and invest the $52,000 savings ($224,872 – $172,915) in stocks, raising their potential for long-term growth.

Like Pfau, speaker Curtis Cloke, the creator of the Thrive method of retirement income generation and the Retirement NextGen retirement planning software, generally follows the floor-and-upside income philosophy, which involves financing essential needs with guaranteed income sources and financing “discretionary” or optional needs as well as legacy goals with risky assets.

But, unlike the academic Pfau, Cloke’s career originated in the insurance sales world, which relies far more on emotion since it involves direct persuasion of clients. His presentation, while partly numbers-driven, was equally dedicated to the emotional dynamics of the annuity sales process and its frequent reliance on building enough trust in the adviser to culminate in the transfer of a large lump sum of money to purchase an irrevocable annuity.

Cloke summarized his philosophy as “Buy income and invest the difference.” He described his retirement income generation methodology as a combination of bucketing and floor-and-upside. It also emphasizes including the purchase of adequate long-term care insurance and health insurance.

A summary of David Blanchett’s presentation on the uncertainty of retirement start dates and its impact on savings targets and retirement income sustainability was published in last week’s edition of RIJ. You can find it here.

Bucketing, Social Security

Another presentation, by a team that included celebrity adviser Harold Evensky, involved comparisons between three bucketing methods and a systematic withdrawal plan as methods of retirement income generation. The team’s other members were Yuanshan Cheng of Winthrop University in South Carolina, who presented the findings, and Tao Guo of William Paterson University in New Jersey.

This team concluded that a time-segmentation bucketing strategy (where retirement was divided into three multi-year periods and specific assets are matched with the income liability during each period) generally outperformed a cash reserve bucket method (a two-bucket system with a cash reserve bucket and a total return portfolio) and a goal-based bucket method (where assets are assigned to specific expenses, such as travel or education for grandchildren).

In their analysis, the team hypothesized a 65-year-old with $2 million and a 30-year time horizon. The retiree’s assumed marginal tax rate was 33% and long-term capital gains rate was 15%. They assumed a real return on equities of 5.1% per year and a real bond return of 0.30% per year.

The time-segmentation bucket (with an initial five-year bucket of bonds, followed by a five-year 50% stocks/50% bonds bucket, and then a 10-year bucket of equities) produced a higher annual income and smaller potential loss than any of the three other methods.

In a well-attended presentation on Social Security, William Reichenstein reviewed all of the special situations that can make it confusing or complicated to decide when and how to file for benefits in an optimal way. His tips and warnings are too numerous to repeat here, but you can glean many of them from Reichenstein’s slides.

In one slide, Reichenstein showed that latent but lucrative claiming strategies still exist, even though regulatory reform has eliminated the famous file-and-suspend strategy made famous by economist/author Larry Kotlikoff of Boston College.

For instance, Reichenstein described a 68-year-old retiree (born before the cut-off date of January 1, 1954) with a 62-year-old wife, who files a restricted application for spousal benefits (half of her full benefits) when she files for her own earned benefits at age 62. At age 70, he files for his own benefit, which includes all deferral credits. Depending on life expectancy, that strategy can be preferable to the husband waiting until age 70 and the wife waiting until her full retirement age (66½) to file for benefits.

Planners and annuities

Mainly through Pfau’s and Cloke’s presentations, financial planners at the FPA/AFS conference received a strong, positive introduction to the role that annuities can play in a retirement portfolio. But, despite the strong attendance at those two sessions, it’s still not clear to what extent planners are amenable to recommending annuities to their clients.

Pfau and Cloke made cases primarily for the use of income annuities, and for the use of those annuities as substitutes for bonds in retirement portfolios. But life insurers, especially non-mutual life insurers, would rather sell variable, index or structured annuities, not income annuities.

Those types of annuities, especially if they have income riders, might be substitutes for bonds or certificates of deposit. But they are just as likely to be substitutes for equities, since they offer direct or indirect access to the equity markets. That difference could confound the insurers’ attempts to communicate with advisers.

Annuity issuers might consider changing the way they talk to advisers about annuities. Insurance companies, whose business involves assuming or buying risk, are inclined to portray risks, including the various retirement risks, as evils. But financial planners and investment advisers are more likely to regard risk as a positive.

For advisers and their clients, risk is the path to reward. It is something to be embraced—gingerly, perhaps, but embraced nonetheless. Pfau and Cloke seemed to understand that, and they emphasized the ability of annuities to add upside potential as well as downside protection to a retirement portfolio.

Insurers should take a cue from them, and try to sell annuities on the basis of greed, not fear. The switch may not come naturally to them, but it may be the best way to win the hearts and minds of advisers.

© 2019 RIJ Publishing LLC. All rights reserved.

The life of RILAs is improving

Posted on October 24, 2019 by -

In a new Special Report, ratings service AM Best predicts that while the current sales volume of Registered Index-Linked Annuities (RILAs) is still small compared with sales of variable annuities (VA) and fixed-index annuities (FIA), RILA likely will outpace other individual annuity products over the near term.

Industry-wide RILA sales totaled $11.2 billion in 2018, representing 11% of all VA sales and 5.6% of total individual annuity sales (fixed and variable combined), according to industry sources. More importantly, RILA sales growth has accelerated since 2016, as sales of traditional VAs declined.

Through the first half of 2019, sales of RILAs totaled $7.7 billion, up 63% over the same period in 2018, and accounted for nearly 16% of industry-wide variable annuity sales and 6.2% of all individual annuity sales.

VA sales peaked at $184 billion in 2007 and have declined since. In 2018, VA sales dropped to about $100 billion, down 46% from 2007. Today, fixed annuity sales, led by FIAs, surpass VA sales, thanks to the uncertainty created by past Department of Labor efforts, abandoned in 2017 by the Trump administration, to regulate VA sales more tightly.

VAs allow for unlimited upside growth potential, but are vulnerable to the risk of loss. FIAs participate indirectly in equity markets through the use of options on the performance of equity or hybrid indexes, so their upside potential is limited. But they provide protection against the risk of loss.

RILAs are a compromise. They offer more upside potential than fixed annuities in exchange for policyholders’ willingness to absorb some risk of loss. Most current offerings feature a combination of guaranteed upside performance caps and downside absorption rates (“buffers” or “floors”). The guarantees are measured over periods as short as one year or as long as 10 years.

Only representatives registered with Financial Industry Regulatory Authority (FINRA) can sell RILAs, so they are likely to see limited penetration into the traditional Insurance Marketing Organization (IMO) channels used heavily by fixed index annuity writers.

However, given the current pace of product introductions, as well as the emerging trend of offering an optional guaranteed minimum withdrawal benefit rider on these products, AM Best believes RILAs will become more popular and constitute a larger portion of individual annuity product sales.

Note: Some distributors dislike the acronym RILA and prefer to call these products “structured” annuities; they resemble structured notes.

© 2019 RIJ Publishing LLC. All rights reserved.

New safe harbor for electronic retirement plan disclosures

Posted on October 24, 2019 by -

In 2002, the DOL issued a safe harbor for electronic disclosure that is available only to those participants that have electronic media at work, and those individuals who affirmatively opt in to electronic documentation.

There have been calls from many quarters for the DOL to update those regulations to reflect the advances in technology since the 2002 regulations, including an August 2018 Executive Order calling upon the DOL, in consultation with Treasury, to explore “the potential for broader use of electronic delivery as a way to improve the effectiveness of disclosures and to reduce their associated costs and burdens.”

In response, on October 22, 2019, the DOL issued proposed regulations establishing a new safe harbor that would allow retirement plan sponsors to satisfy disclosure requirements by notifying participants and beneficiaries that the information will be made available on a website.

The proposed regulations only apply to pension plan disclosures, rather than welfare plan disclosures, such as group health plans and disability plans, although the proposed regulations have reserved consideration of applying these rules to welfare benefit plans.

When final regulations are issued, they will be effective 60 days after the notice is published in the Federal Register, but because this new safe harbor is voluntary and optional, the applicability date, which frequently is after the effective date, will be the first day of the first calendar year following publication of the final rule.

The proposed regulation applies to participants and beneficiaries who are entitled to covered documents and who, as a condition of employment, either at the beginning of plan participation or otherwise, provide the plan sponsor, employer, or plan administrator, with an email address.

However, this requirement is satisfied if an employer assigns an electronic address to an employee. At the time that a covered individual severs from employment with the employer, the administrator must take reasonable measures to ensure the continued accuracy of the electronic address the employer has been provided, or alternatively to obtain a new electronic address.

A covered document is any document that the administrator is required to furnish to participants and beneficiaries under Title I of ERISA, except for documents that must be furnished upon request.

Prior to reliance upon these proposed regulations, a plan administrator must furnish to each individual:

  • A paper notification that some or all covered documents will be provided electronically
  • A statement of the right to request and obtain a paper version of the requested document, free of charge
  • The right to opt out of receiving documents electronically, and an explanation of how to exercise these rights.

A notice of Internet availability must generally be furnished at the time the covered document is made available on the website. However, if the administrator furnishes a combined notice of internet availability for certain specified documents, then the combined notice must be furnished each plan year, and, if the combined notice was furnished in a prior plan year, the notice must be provided no more than 14 months following the date that the prior plan year’s notice was furnished.

The proposed regulations also dictate the content of the disclosure, including a prominent statement such as “Disclosure about Your Retirement Plan” and a statement that “Important Information about your retirement plan is available at the website address below. Please review this information,” as well as:

  • A brief description of the covered document
  • The Internet website address where the information is available
  • A statement of the right to request and obtain a paper version
  • A statement of the right to opt out of receiving electronic documents
  • A telephone number to contact the administrator or other designated plan representative

The notice can only contain the content described in the proposed regulations, other than design elements; and must be written in a manner calculated to be understood by the average plan participant.

The administrator is also required to ensure that the covered document is available on the website no later than the date on which the covered document:

  • Must be furnished under ERISA
  • Must remain available on the website until it is superseded by a subsequent version of the covered document
  • Must be presented in a manner calculated to be understood by the average plan participant
  • Must be presented in a format that is suitable to be both read online and printed clearly on paper, and the document can be searched electronically by numbers, letters, or words.

The administrator must also take measures reasonably calculated to protect the confidentiality of a covered individual’s personal information.

Additionally, upon request from a covered individual, the administrator must promptly furnish to each individual free of charge, a paper copy of a covered document, and the covered individual must have the right to opt out of electronic delivery and receive paper versions of some or all covered documents.

The system for furnishing notice of Internet availability must be designed to notify the administrator of a covered individual’s invalid or inoperable electronic address. If the administrator’s reasonable attempts to correct the problem, such as sending the notice to a secondary email address, do not work, the administrator must treat the covered individual as if he or she had elected to opt out of electronic document delivery.

Finally, [if] covered documents are temporarily unavailable on a website due to unforeseeable events or events beyond the control of the plan administrator, the conditions of the proposed regulations will continue to be treated as satisfied, provided that the administrator has reasonable procedures in place to ensure that covered documents are available in the manner required by the regulations, and the administrator takes prompt action to ensure that the documents become available as soon as practicable.

© 2019 Wagner Law Group.

It’s Too Late for ‘Medicare for All’

Posted on October 24, 2019 by -

Medicare for All ain’t gonna happen.

Even as Democratic presidential candidates chat up the possibility of extending a single-payer, publicly operated, no-deductible, zero co-pay version of Medicare to all Americans regardless of age, today’s elderly-only Medicare resembles such a program less and less.

Instead, Medicare has been evolving into the multi-payer, privately operated high-deductible program known as Medicare Advantage. Already, about a third of Medicare-eligible seniors, or 22 million people, use private HMO- or PPO-style Medicare Advantage plans instead of traditional fee-for-service Medicare.

By 2029, an estimated 42% to 47% of seniors are expected to use Medicare Advantage plans instead of traditional Medicare alone or traditional Medicare with a Medigap supplement. Your father’s Medicare isn’t growing; it’s disappearing.

“The Medicare of tomorrow could look much different than it does today—more like a marketplace of private plans, with a backup public plan, and less like a national insurance program,” wrote health economists Patricia Neuman and Gretchen Jacobson in The New England Journal of Medicine a year ago. “This may or may not be the program that people envision when they talk about Medicare for All.”

In short, the government has been steadily outsourcing Medicare to private health insurance companies for more than 15 years, creating a massive, federally subsidized industry so profitable that it attracts more entrants every year.

Medicare today pays more than $200 billion a year—not as reimbursements for services, but in advance, as capitation payments—to Medicare Advantage providers like Humana and United Healthcare, plus an estimated $6 billion in performance bonuses. That transfer is projected to reach $580 billion in 10 years, according to Neuman and Jacobson.

Medicare is a single-payer plan today, but it’s biggest payment is to Medicare Advantage. In their last debate, as Elizabeth Warren and Bernie Sanders described their ideas for taking plans for making Medicare more purely public, President Trump was taking steps to make it more market-driven. His October 3 executive order calls for an analysis of ways “to inject market pricing into Medicare FFS reimbursement.”

Financial advisers need to be aware of all this, because they’re in a position to save their older clients a lot of money by steering them to the right kind of coverage. Medicare Advantage plans, with their low premiums but high deductibles, can be penny-wise but pound-foolish. Traditional Medicare plus a Medigap insurance plan could save them a lot of grief and expense in the long run.

At first glance, Medicare Advantage plans look irresistible to many 65-year-olds. The convenience of one-stop shopping for medical, drug, vision and dental coverage appeals to people accustomed to corporate health care benefits. The zero monthly premium options are alluring to people with low incomes. Plans can differentiate themselves by offering freebies that, as of 2020, can include non-medical services like home-delivered meals.

Often, in any given locality, the same familiar companies that provide corporate and individual health insurance also offer Medicare Advantage plans, and they heavily promote them every fall during the Medicare re-enrollment period, when people can switch plans. Individual agents also sell Medicare Advantage plans, attracted by $510-per-enrollee commissions.

“If I write a MAPD [Medicare Advantage plus drug] contract I get $500, and if I write a Medigap policy I get $250,” said Joanne Giardini-Russell, founder of Boomer Health Group near Lansing, Michigan. “This is what agents are pushing, and there’s often no mention of the Medigap option.”

But there are clawbacks, and some are irreversible. If your client gets sick, out-of-pocket costs can mount up. If the client has a diagnosis of cancer, for instance, the co-pays can mean maximum annual expenses of $6,700 (the current Medicare Advantage cap for in-network care) or $10,000 (the maximum for PPO plans), according to 65incorporated.com. Drug expenses may drive the cost higher.

At that point, he or she will have a pre-existing condition and either won’t qualify for a Medigap plan at an attractive price, or not at all. Also, Medicare Advantage patients may face the frustrations of utilization review, prior authorization and referral requirements, higher out-of-network charges, and unforeseeable changes in coverage from year to year.

Initially, Medigap plans aren’t cheap. The monthly premiums range from under $50 to over $200, depending on medical costs in your client’s state of residence. (This is on top of the standard monthly Medicare premium of $135 or more, depending on income, which may come out of your clients’ Social Security checks.) Nor do they offer one-stop shopping. Drug, vision and dental policies typically have to be purchased separately. (As of Jan. 1, 2020, Medigap plans will no longer cover the Medicare Part B deductible. See Medicare handbook for 2020.)

But Medigap plans, as a supplement to traditional Medicare, make life simpler and can save money later in life, when medical care becomes more frequent and more serious. Expenses are predictable, with few or no co-pays or deductibles. Medigap policyholders face unrestricted choice of physicians (among those who accept Medicare). As long as they sign up for Medigap plan when they first sign up for Medicare at age 65 or soon after, they can’t be refused coverage or charged higher premiums, even with a pre-existing condition. To look for a Medigap plan, click here.

Unfortunately, the future of Medicare is now caught between opposing political forces. Sanders and Warren are pulling for expansion of an all-public Medicare program for all Americans. Republicans are pulling for a more market-driven system. Just as no one is quite sure yet how the Democrats’ Medicare for All would work, no one I spoke to understood President Trump’s October 3 executive order—especially the part that suggests letting Medicare Advantage providers set their own reimbursement rates.

“The section of the executive order about commercial rates was a little surprising,” Gretchen Jacobson told RIJ. “Was it to tie traditional Medicare rates to market values, or was it to lower costs?”

If Democrats ever control all three branches of the federal government, they might fulfill the Sanders-Warren vision of reversing the outsourcing of Medicare to Medicare Advantage providers.

But no one expects that, just as no one who spoke with RIJ believed that the politically powerful Medicare Advantage genie can be coaxed or forced back into its bottle. If anything, it’s on track to replace traditional Medicare entirely.

© 2019 RIJ Publishing LLC. All rights reserved.

Uncertainty at Both Ends of Retirement

Posted on October 18, 2019 by -

Uncertain lifespans are a well-known confounder of the best-laid personal retirement plans, for advisers and clients. Uncertainty about the retirement start date makes the planning process doubly hard.

Welcome to a newly identified of longevity risk: the front-loaded kind. The problem might seem too obvious to attract academic attention, but David Blanchett of Morningstar just won the Montgomery-Warshauer Award from the Financial Planning Association for his paper on it.

Blanchett, the head of retirement research at Morningstar, presented the 2018 paper to several hundred financial planners at the 2019 FPA annual conference in Minneapolis yesterday. The gist of his paper is a heuristic that he chooses to call “the Rule of 61.”

David Blanchett

“Individuals targeting a retirement before age 61 tend to retire later than expected,” Blanchett writes in the paper. “Individuals targeting a retirement age of 61 retire when expected; and those targeting a retirement age after 61 generally retire approximately a half-year early for each additional year of work planned past age 61.”

Along with all the other retirement risks that advisers need to anticipate for clients as they approach—sequence risk, market risk, inflation risk, health risk, and longevity risk, to name only a few—advisers should also factor in the likelihood that a client might retire two years earlier or later than they told you they would.

For a client who retires a few years earlier that expected—and who stops working earlier—the implications on his or her retirement savings target can be significant. Once you factor in a shorter saving period, a longer retirement, and a smaller Social Security benefit, an early retiree might need to save 25% more than expected to enjoy the same level of retirement security.

“If the “average investor” is assumed to be seeking a 4% initial withdrawal rate (i.e., a moderate success target) and wants to retire at age 65,” Blanchett wrote, “the impact of retirement age uncertainty would require approximately 25% more savings than suggested by traditional models (28.29% to be exact).”

Blanchett based his findings largely on the Health and Retirement Study, a long-term population study by the Rand Corporation, the Social Security Administration, and the Centers for Retirement Research. Participants in the study have been interviewed every two years since 1992.

His projections varied from person to person, he found, depending on several variables, including, health, gender, education, marital status, housing wealth, savings, occupation, income, and remaining years to retirement.

“Half of your clients will retire earlier than expected,” Blanchett told the planners. About 24% of those who retire early do so because they can afford to. About 10% retire to pursue other activities. The remaining 66% retire because of ill health, layoffs or the need to care for an ailing spouse, he said.

Ironically, those who can afford to retire early, such as highly educated professionals, tend to work longer and retire later, Blanchett pointed out. Those who need to work longer, who have earned and saved less prior to retirement, are often the ones who are forced to retire early because of poor health or job loss.

Advisers need to recognize that their clients don’t necessarily have control over their retirement date, and to plan accordingly. “Ignoring retirement age uncertainty can potentially have a significant (negative) impact on potential retirement outcomes,” Blanchett wrote. “Therefore, financial planners should consider showing clients the implications of an early retirement to potentially get them to save more than they would using a more traditional approach where retirement age is treated as certain.”

© 2019 RIJ Publishing LLC. All rights reserved.

Global aging named as world’s most powerful trend

Posted on October 18, 2019 by -

An aging population was identified as the most significant driver of global economies and the investment landscape over the next 30 years, according to a poll of institutional investors sponsored by Investcorp, Mercury Capital Advisors, IMD Business School and ICR.

The demographic shift was selected by 78% of institutional investors surveyed. Artificial intelligence (AI) and machine learning ranked second (69%) and climate change third (66%), followed by “urbanization and smart cities” (42%) and redefining global trade (40%).

A study based on the survey, “What’s Next? Investment Trends for the Future,” was released this week. Here are descriptions of the world-changing factors that investors identified:

Aging population. Nearly 8 out of 10 (78%) of investors polled cited an “Aging Population” as the top trend that will shape the global economic landscape. Participants were more likely to invest in this trend through private markets (62%) than public markets (26%), with more than half of the allocation to private markets manifesting itself via private equity (38%) and real estate (21%) based strategies. Participants believe that this trend will peak around the years 2030-2032.

AI and machine learning. Participants were more than twice as likely to invest in this theme through private markets (58%) than public markets (25%). Those who did invest through private markets preferred to deploy capital through venture capital (44%) and private equity (34%). Participants believe that this trend will peak around the years 2030-2032.

Impact of climate change. Climate change ranked as the third most significant trend. Participants were more likely to invest in the impact of climate change through private markets (48%) compared to public markets (27%).

Urbanization and smart cities. Among the top five trends identified, this theme counted the highest percentage of investor access via private markets (67%) and the lowest access through public markets (20%). Private markets allocation is relatively even among private equity (26%), real estate (25%), venture capital (25%) and infrastructure (17%).

Redefining global trade. Among the top five most important trends investors cited, redefining global trade generated the most equal representation of allocation between private markets (47%) and public markets (43%). This trend also saw private equity as the main private market asset class to deploy capital (45%). Participants believe that this trend will peak between 2023 and 2024, the earliest period among all topics surveyed.

The survey received responses from 185 investors representing more than US $10 trillion in AUM across a range of institution types including: pension funds, sovereign wealth funds, foundations, endowments, insurance companies, consultants, funds of funds and family offices.

Approximately 60% of the respondents were senior executives at their organizations, identifying themselves as CIOs, heads of investment groups, managing directors and partners. Two-thirds (66%) of survey participants managed portfolios with an alternative/private markets tilt, with the remainder (34%) having a traditional/public market tilt.

Investcorp is a $28.2 billion provider of alternative investment products, and IMD Business School is an executive education institution based in Lausanne, Switzerland. ICR is a communications firm and Mercury Capital Advisors has raised some $170 billion from institutional investors for its clients.

© 2019 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Posted on October 18, 2019 by -

A new bond index fund from Fidelity

Fidelity Investments, a long-time specialist in actively managed mutual funds, has launched another index fund as part of its strategic adaptation to the ongoing trend toward low-cost passive investing. The new fund is Fidelity International Bond Index Fund (FBIIX), according to an announcement this week.

The new fund’s total net expense ratio is 0.06%. Like other Fidelity index funds, its total expenses are “lower than its comparable Vanguard fund,” the Fidelity release emphasized. The fund has no minimum investment. Fidelity now has $530 billion in index mutual fund assets under management as of August 31, 2019, the release said.

Nassau buys Foresters

Nassau Life Insurance Company will acquire Foresters Financial Holding Company, Inc. and Foresters Life Insurance and Annuity Company from The Independent Order of Foresters, Nassau Financial Group announced this week.

The transaction between the two New York-domiciled firms is expected to close in the first quarter of 2020 and is subject to customary closing conditions, including regulatory approval by the New York State Department of Financial Services.

Founded in 1962, Foresters Life Insurance and Annuity serves about112,000 policyholders and has $2.5 billion in assets. The company has offices in Edison, NJ and New York, NY. Goldman Sachs & Co. LLC served as financial advisor and Eversheds Sutherland (US) LLP served as legal advisor to Nassau.

Nassau Financial Group has combined assets of approximately $22.6 billion and capital of approximately $1.3 billion. Nassau was founded in 2015 with capital provided by Golden Gate Capital, a private investment firm with over $15 billion of committed capital.

Distribution expands for T. Rowe Price model portfolios

The T. Rowe Price Target Allocation Active Series Model Portfolios are now available to financial advisors through Morningstar’s Model Marketplace, the retirement plan and mutual fund company announced this week.

Model Marketplace, available through Morningstar Office Cloud, launched in May 2019 and serves as a centralized distribution platform for advisors, allowing users to research investment models, personalize strategies, and initiate trade instructions.

The Target Allocation Active Series Model Portfolios were first made available on the Envestnet Fund Strategist Portfolio (FSP) and Unified Managed Account (UMA) Programs.

The Target Allocation Active Series on Morningstar’s Model Marketplace consists of eight professionally managed, risk-based asset allocation models with both retail and institutional mutual funds that are designed to meet a wide range of investment objectives. The model portfolios use globally diverse T. Rowe Price equity and fixed income mutual funds as their underlying investments.

Portfolio managers Charles Shriver, Toby Thompson, Robert Panariello, Guido Stubenrauch, and Andrew Jacobs van Merlen manage the Target Allocation Active Series. Each portfolio manager is a member of the T. Rowe Price Multi-Asset team, which had $332.5 billion in assets under management as of June 30, 2019.

© 2019 RIJ Publishing LLC. All rights reserved.

 

Most advisory firms not qualified to rely on their own research: Cerulli

Posted on October 18, 2019 by -

While more than six in 10 advisers and 55% of all advisory practices rely on their own investment research and portfolio construction, only about 7% of those practices are at an optimal scale to do so, according to new research from Cerulli Associates.

The research, published in the 4Q 2019 issue of The Cerulli Edge—U.S. Advisor Edition, further reveals that these practices, otherwise referred to as Optimal Non-Users (i.e., non-users of prepackaged models), have similar structures, staff, and services.

Baseline criteria to be considered an Optimal Non-User of centralized models is a team-based environment, staffed appropriately with layers of stakeholders and asset-gatherers supported by the resources needed to customize portfolios, retain existing relationships, attract new clients, and build rapport with families’ beneficiaries and outside advisors.

Cerulli finds that firms with an average account size of $2 million and greater, and a minimum AUM floor of $250 million are candidates for the Optimal Non-User segment, but the practices that can genuinely customize portfolios skew closer to the $500 million range. Optimal Non-Users are exponentially more likely to reside within the wirehouse, hybrid registered investment advisor (RIA), and independent RIA channels.

Lastly, because of their scale, these practices value different offerings from distribution teams. They place greater value on competitive product information and commentary from portfolio managers compared with other topics, including client educational content, interactive tools, and practice management programs, that smaller practices crave most.

“Of all Optimal Non-User practice types, wealth managers are the most likely practice type to exhibit the defining characteristics,” said Donnie Ethier, director of wealth management at Cerulli, in a press release. “Not only do they offer the most advanced planning options, but they are also led by the industry’s most experienced and educated advisors, resulting in leadership that focuses on developing business scale.

“Third parties should evaluate their target practices to segment opportunities and design distribution strategies if they hope to engage these teams,” Ethier added. “Segmentation can also help wealth management executives evaluate their own teams and better assess which may be adequately prepared to work outside of home-office resources if they insist.”

© 2019 RIJ Publishing LLC. All rights reserved.

Research Roundup

Posted on October 18, 2019 by -

Five recent working papers from the National Bureau of Economic Research offer intriguing insights into the economic implications and effects of an aging society. The papers are listed below (links and extended summaries follow):

  • “Retirement in the Shadow (Banking)” suggests that the main culprit in the financial crisis wasn’t all bad for retirement savers.
  • “Demographics and Monetary Policy Shocks” shows that interest rate fluctuations may impact older investors most.
  • “Population Aging and Structural Transformation” links the graying of America and our increasingly health care-driven service economy.
  • “A Retrieved-Content Theory of Decision-Making” asserts that there’s more to behavioral finance than “thinking fast and slow.”
  • “The Effects of Job Characteristics on Retirement” shows that psychological factors, in addition to economic factors, affect when, how, and why Americans retire.

“Retirement in the Shadow (Banking)” by Guillermo Ordoñez University of Pennsylvania and Facundo Piguillem of the Einaudi Institute for Economics and Finance. NBER Working Paper 26337, October 2019.

Here’s a puzzler for both actuaries and quants: Are recent gains in post-retirement life expectancy related to the expansion of securitization and shadow banking (defined as borrowing, lending, saving and investment activities that take place outside the regulated banking system)? If so, is that good or bad?

Guillermo Ordoñez of Penn and Facundo Piguillem of Italy’s EIEF (Einaudi Institute for Economics and Finance) explain that the need for higher returns among >65 savers in the U.S., who hold about one-third of total wealth in the U.S., created demand for the assets created and brokered by investment banks.

“When expecting to live longer, [investors] rely more heavily on intermediaries that use securitization, with riskier but higher returns,” the economists write. “[Our] model shows the potential of the demographic transition to account for a boom in credit and output, but only when it triggers a more extensive use of securitization and shadow banking.”

In terms of national output, aging and securitization combined to create a significant net gain, they claim. “The gains from operating with shadow banking from 1980 to 2007 were in the order of 60% of 2007 GDP. Further, even if we blame the great recession exclusively to the operation of shadow banks, its cost was in the order of 14% of 2007 GDP… In short, our model suggests that there were net gains to having shadow banks, even if it were true that they single handedly generated the recent crisis.”

They leave open the question: Were the causers of the crisis also the winners?

“Demographics and Monetary Policy Shocks,” by Kimberly A. Berg (Miami U.), Chadwick C. Curtis (U. of Richmond), Steven Lugauer (U. of Kentucky), and Nelson C. Marks (Notre Dame). NBER Working Paper 25970, October 2019.

Anecdotally, working-age people ignore news of upticks or downticks in the Fed funds rate but retirees pay closer attention to CNBC and The Nightly Business Report. In this paper, four economists explain why retirees might be relatively more engaged by monetary policy changes.

Older people tend to be wealthier, their income often fluctuates with the value of their financial capital, and Fed interest rate policy directly affects that value. Using data from the Survey of Consumer Finances, the economists “point out that They point out that older households are more likely to be retired, and to be financing their consumption from investment income or from the sale of accumulated assets than their younger counterparts.

“Older households are also much more likely to hold long-term assets, whose values are sensitive to changes in interest rates. Thus an increase in interest rates—a shift toward a more contractionary monetary policy—would reduce wealth by more for older than for younger households. This wealth effect in turn leads to lower consumer spending.”

“Population Aging and Structural Transformation,” by Javier Cravino, Andrei A. Levchenko, and Marco Rojas, all of the U. of Michigan economics department. NBER Working Paper 26327.

Over the past 35 years, Americans have gradually been spending more of their income on services and less on goods. Between 1982 and 1991, we spent about 63% of our money on goods (cars, furniture, clothes, etc.) and the rest on services (health care, utilities, dining out). Between 2002 and 2016, the balance shifted to 57% on goods and 43% on services.

An increase in the relative prices of services (like high-tech health care) vs. the prices of goods (like Chinese-made apparel) accounted for about two-thirds of that shift. But the aging of the U.S. population caused about 20% of it, according to this paper by three U. of Michigan economists. They believe that the impact of aging on the consumption of services will be even stronger in the decades ahead.

“Changes in the US population age distribution accounted for about a fifth of the increase in the share of services in consumption expenditures observed between 1982 and 2016,” they write. “According to our quantitative model, population aging plays a much larger role than changes in real income in accounting for the structural change observed in the US during this period.”

The rising percentage of the population over 60 and their larger consumption of health seem to be the key factors.

“Households 65 and older accounted for 10.4% of total expenditures in 1982, and 19.8% in 2016, a 90% increase. The share of expenditures that goes to households 80 and older nearly tripled, going from 1.2% to 3.4%. The counterpart of this increase is the decline in the share of expenditures that goes to households 30 and younger, from 47.3% to 31.6%.”

Moreover, “The largest disparity (between spending on services by young and old) arises in health expenditures, where the consumption expenditure share of the 60-65 (80+) age group is 5.6 (15.3) percentage points larger than that of the 25-30 age group.” The service consumption expenditure share for those ages 80+ is 15.3 percentage points higher than the younger group.

“A Retrieved-Context Theory of Financial Decision-Making,” by Jessica A Wachter and Michael Jacob Kahana of the U. of Pennsylvania. NBER Working Paper 26200, August 2019.

A new etiology of behavioral finance is proposed in this paper by a finance professor and a psychology professor at Penn. Jessica A. Wachter and Michael J. Kahana challenge Daniel Kahneman’s Nobel Prize winning idea that cognitive biases such as loss aversion and narrow framing explain apparently irrational decisions.

Instead, they point to human learning and memory as the hidden determinants in financial decision-making. They hypothesize, for instance, that investors panicked in 2008 because the Lehman Brothers bankruptcy revived traumatic memories of the Great Depression, and not because their financial security was threatened.

“Our hypothesis is that the financial crisis was a psychological event caused by the failure of Lehman Brothers. The actual realization of an important financial institution failing in the absence of insurance reminded investors of the Great Depression. Some felt that they had—literally—returned to the Great Depression,” they write.

“Investors experienced what the memory literature refers to as a jump back in time. Once this feeling entered the discourse, it proved hard to shake. Subsequent events showed that in fact there was no Great Depression. This was only revealed, though, over time. Somehow, what emerged from the crisis and recession was not a feeling of relief but rather a renewed emphasis on the fragility of the financial sector and the possibility that a Great Depression might in fact occur.”

The authors go on to explain the mechanism behind their hypothesis. “Three major laws govern the human memory system: similarity, contiguity, and recency:

  • Similarity refers to the priority accorded to information that is similar to the presently active features
  • Contiguity refers to the priority given to features that share a history of co-occurrence with the presently active features
  • Recency refers to priority given to recently experienced features.

All three “laws” exhibit universality across agents, feature types, and memory tasks and thus provide a strong basis for a theory of economic decision-making.” The researchers do not believe that the crisis revealed an inherently fragile shadow banking system overdosing on leverage; rather, it reflected investor over-reaction.

“The Effects of Job Characteristics on Retirement,” by Péter Hudomiet, Michael D. Hurd, Andrew Parker and Susann Rohwedder, RAND Corporation. (NBER Working Paper 26332).

Older Americans would be almost twice as agreeable to working longer if employers offered them flexible work hours, according to a survey conducted by the RAND Corporation. Analysts there found that “the fraction of individuals working after age 70 would be 32.2% if all workers had flexible hours, while the fraction working would be 17.2% if none had the option of flexible hours.”

The survey revealed a strong preference among Americans for making a clean break from employment; that is, for retiring “directly and completely” from a full-time job. About half preferred to retire this way. Almost a quarter preferred to ease into retirement with a part-time job, while 8% preferred a period of self-employment before retirement, and a little over 10% said they preferred to work “forever.”

Women were more inclined to a part-time job or self-employment before full retirement, and they were less likely to prefer never retiring. Part-time employees and self-employed workers were more likely than full-time employees to prefer the gradual pathways.

Stress, heavy physical and cognitive job demands, the option to telecommute, and commuting times also influenced attitudes toward working at an older age. The survey showed people would like preretirement jobs to be less cognitively and physically demanding and more sociable compared to their current jobs. Most workers said they worry about their health and the demands of their jobs when they think about their future work trajectory, but relatively few worried that their employers would not retain them.

“Standard theory ignores psychological factors, but our results suggest that they may be useful to understand heterogeneity in the population that is not explained by standard economic variables,” the RAND researchers concluded.

© 2019 RIJ Publishing LLC. All rights reserved.

Joint venture eyes distressed annuity books

Posted on October 10, 2019 by -

Värde Partners, a private equity firm, and Agam Capital, creator of an insurance solutions platform, are forming a joint venture to pursue “the acquisition, reinsurance and management of life and retirement businesses globally,” according to a release this week.

The joint venture will “price and manage complex insurance products with embedded market and actuarial risks, on a global basis” and “serve as a turnkey solution for financial modeling and enterprise risk management” for life insurance companies.

Värde Partners plans to invest $500 million in complex life insurance, annuity, and reinsurance assets, marking the expansion of its private equity strategy into insurance. Elena Lieskovska, partner and head of European Financial Services at Värde Partners, said:
“Given the current landscape of historically low interest rates and fundamental regulatory and accounting changes, we believe the opportunity across the $23 trillion life insurance industry is huge. Life insurance companies are increasingly seeking risk mitigation solutions for legacy blocks of liabilities with multi-dimensional risks. This is particularly true for complex annuity products, such as those with high guarantees or exposure to certain market risks, which typically attract a higher capital charge.”

Agam’s Co-Founders, Avi Katz and Chak Raghunathan said his platform “is designed to price, analyze and manage complex insurance products with embedded capital market risks.” The platform uses “machine learning, predictive data analytics and cloud computing to evaluate and assess complex insurance liabilities” including “integrating transaction modeling with actuarial cash flows.”
Värde Partners is a $14 billion global alternative investment firm that employs a value-based approach to invest in corporate and traded credit, real estate, mortgages, financial services, real assets and infrastructure. Its investor base includes foundations and endowments, pension plans, insurance companies, other institutional investors and private clients. The firm has headquarters in Minneapolis, London and Singapore.
Agam is a New Jersey-based insurance solutions provider, founded by Abraham Katz and Chak Raghunathan, senior executives from Apollo Global Management and Aflac Inc.

“While traditional insurance solutions have been aimed at enhancing asset yield to support a liability structure, Agam has focused its efforts on building technology for risk management with integrated analytics. Agam’s expertise is to develop solutions for complex cash flow streams through greater hedging optimization and meaningfully lower operating costs,” the executives said in the release.

© 2019 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Posted on October 10, 2019 by -

Lincoln launches two new fee-based annuities for RIAs

Lincoln Financial Group has introduced two new products for registered investment advisors (RIAs): A single premium immediate annuity (SPIA), Lincoln Insured Income Advisory, and a deferred income annuity, Lincoln Deferred Income Solutions Advisory.

Both are commission-free, allowing fee-based advisers to charge an asset-based fee instead. Lincoln said its annuity sales in the fee-based space have increased more than 150% year-over-year as of June 2019.

Tad Fifer, vice president and head of RIA Annuity Distribution, Lincoln Financial Distributors, said in a release, “We are offering a broad portfolio of solutions for RIAs who choose to include annuities as part of their clients’ retirement plans. Income annuities can help secure life-long or period-certain cash flow with the potential for higher income payout than other available options.”

Over the past year, Lincoln said it has established technology integrations with Orion, eMoney, Envestnet/Tamarac, Redtail and others. These data integrations are designed to make it easier for advisers to incorporate annuities into their clients’ financial planning strategies.

The company also recently implemented a more seamless tax treatment of advisory fees taken from certain non-qualified fee-based annuities. This new treatment affects Lincoln’s fee-based and RIA variable, fixed and indexed variable annuity products (non-SPIA/DIA).

The treatment follows a Private Letter Ruling Lincoln received from the Internal Revenue Service, allowing fee-based advisors to deduct fees related to investment advisory services provided for Lincoln annuity contracts without triggering a taxable event for their clients, assuming certain conditions are met.

Broadridge to buy Fi360

Broadridge Financial Solutions, Inc., a part of the S&P 500 Index, has entered into a purchase agreement to acquire Fi360, Inc. Fi360 is a leading provider of fiduciary-focused software, data and analytics for financial advisors and intermediaries across the retirement and wealth ecosystem.

Fi360 also provides the accreditation and continuing education for the Accredited Investment Fiduciary (AIF) Designation, the leading designation focused on fiduciary responsibility.

The acquisition is expected to close in November. Raymond James & Associates is acting as financial advisor to Fi360 in the transaction. Terms of the transaction were not disclosed.

Broadridge’s acquisition of Fi360 is intended to enhance its existing retirement solutions by providing wealth and retirement advisors with fiduciary tools that complement its Matrix trust and trading platform. The acquisition will also strengthen Broadridge’s data and analytics tools and solutions suite.

“The shift to fee-based advice and imminent regulatory changes, including the SEC’s Regulation Best Interest, are increasing the scrutiny on firms to ensure that they are demonstrating prudent advisory practices,” said Michael Liberatore, head of Broadridge’s Mutual Fund and Retirement Solutions business. “Our goal is to help firms stay ahead of this evolving regulatory landscape.”

Fi360 provides analytical and reporting software that helps investment professionals document investment processes and evaluate products. The software enables broker-dealers to automate compliance procedures and identify at-risk assets.

The company’s online and in-classroom training and ongoing annual designations are designed to help retirement, wealth and other investment professionals serve their clients’ best interests. Fi360 has awarded the AIF Designation to over 11,000 advisors since 2003.

SEC forms Asset Management Advisory Committee

The Securities and Exchange Commission today announced the formation of its Asset Management Advisory Committee.The committee was formed to provide the Commission with diverse perspectives on asset management and related advice and recommendations.

Topics the committee may address include trends and developments affecting investors and market participants, the effects of globalization, and changes in the role of technology and service providers.

The committee is comprised of a group of non-governmental experts, including individuals representing the views of retail and institutional investors, small and large funds, intermediaries, and other market participants.

SEC Chairman Jay Clayton has appointed Edward Bernard, Senior Advisor to T. Rowe Price, as the initial committee Chairman. Other committee members include:

  • John Bajkowski, President and Chief Executive Officer, American Association of Individual Investors
  • Michelle McCarthy Beck, Chief Risk Officer, TIAA Financial Solutions
  • Jane Carten, Director, President, Director, and Portfolio Manager, Saturna Capital
  • Scot E. Draeger, President-Elect, General Counsel, and Director of Wealth Management, R.M. Davis Inc.
  • Mike Durbin, President, Fidelity Institutional
  • Gilbert Garcia, Managing Partner, Garcia Hamilton & Associates
  • Paul Greff, Chief Investment Officer, Ohio Public Employees Retirement System
  • Rich Hall, Deputy Chief Investment Officer, The University of Texas/Texas A&M Investment Management Co.
  • Neesha Hathi, Executive Vice President and Chief Digital Officer, Charles Schwab Corp.
  • Adeel Jivraj, Partner, Ernst & Young LLP
  • Ryan Ludt, Principal and Global Head of ETF Capital Markets and Broker/Index Relations, Vanguard
  • Susan McGee, Board Member, Goldman Sachs BDC Inc.
  • Jeffrey Ptak, Head of Global Manager Research, Morningstar Research Services
  • Erik Sirri, Professor of Finance, Babson College, and Independent Trustee, Natixis Funds, Loomis Sayles Funds, and Natixis ETFs
  • Aye Soe, Managing Director and Global Head of Product Management, S&P Dow Jones Indices
  • Ross Stevens, Founder and Chief Executive Officer, Stone Ridge Asset Management
  • Rama Subramaniam, Head of Systematic Asset Management, GTS
  • John Suydam, Chief Legal Officer, Apollo Global Management
  • Mark Tibergien, Managing Director and Chief Executive Officer of Advisor Solutions, BNY Mellon | Pershing
  • Russ Wermers, Dean’s Chair in Finance and Chairman of the Finance Department, University of Maryland’s Smith School of Business, and Managing Member, Wermers Consulting LLC
  • Alex Glass, Indiana Securities Commissioner (non-voting)
  • Tom Selman, Executive Vice President, Regulatory Policy, and Legal Compliance Officer, FINRA (non-voting)

The committee will be formally established on Nov. 1, 2019 for an initial two-year term, which can be renewed by the Commission. The Commission will announce further details about the committee in the near future.

Schwab to offer Pacific Life fee-based investment-only variable annuity

Pacific Odyssey, Pacific Life’s no-commission variable annuity for fee-based advisers who charge clients a percentage of assets under management, is now available to independent Registered Investment Advisors through Schwab Advisor Services.

In addition to the fee charged by their advisers, owners of the contract would pay a 0.30% annual expense ratio on the separate account investments and 0.15% annual mortality and expense risk charge.

The free death benefit promises return of the account value at the contract owner’s death, according to a release from Brian Woolfolk, FSA, MAAA, senior vice president of sales and chief marketing officer for Pacific Life’s Retirement Solutions Division.

Through the Schwab Annuity Concierge Service for Advisors, advisers get free assistance with contract fulfillment from insurance-licensed phone reps, the release said.

Schwab Advisor Services, Charles Schwab Insurance Services and Pacific Life are separate, unaffiliated firms.

Mesirow, Financial Soundings partner on 401(k) managed account service

Mesirow Financial today announced the launch of Mesirow Financial Precision Retirement, a participant managed account program that is designed to enhance financial wellness and offer professional portfolio management for retirement assets.

Mesirow Financial Precision Retirement combines retirement planning advice and reporting, proactive dynamic messaging to achieve targeted outcomes, and Mesirow Financial’s custom portfolio construction expertise, said Michael Annin, Head of Investment Strategies at Mesirow Financial, in a release.

Mesirow Financial partnered with fintech provider Financial Soundings to leverage its proven Retirement Planning Insights program and expand upon the offering to include participant managed account functionality. Financial Soundings has a history of increasing the utilization of employee retirement benefits and improving retirement readiness scoring, said Steve Maschino CEO & President of Financial Soundings

Mesirow Financial Precision Retirement enables plan sponsors to offer online advice based on a participant’s unique situation, the ability to model what-if scenarios, and on-demand reporting.

More investors see a recession approaching: Allianz Life

Fully half of Americans now fear the onset of a major recession, according to the latest Allianz Quarterly Market Perceptions Study. “Consumers are increasingly anxious about the effects of market volatility on their finances,” according to the Q3 findings from Allianz Life.

Increasing numbers of respondents also say they worry that a “big market crash” is “on the horizon” (48% in Q3 compared with 47% in Q2 and 46% in Q1), said Kelly LaVigne, vice president of Advanced Markets, Allianz Life, in a release.

Among Millennials, 56% say they are worried about a recession being right around the corner, compared with 51% of Gen Xers and 46% of boomers. Millennials are twice as likely as Boomers however to say they are “comfortable with market conditions and ready to invest now” (47% of Millennials and just 17% of Boomers).

The share of respondents who say it’s important to have some retirement savings in a financial product that protects from loss has been trending down (66% in Q3 compared with 72% in Q2). But the share of respondents who favored putting some money into a financial product that offers modest growth potential with no potential loss is up (24% in Q3 compared with 18% in Q2).

Fraternals are feeling hazed: AM Best

Companies in the fraternal segment of the U.S. life insurance industry are struggling to stay competitive, given their limited financial resources and difficulties in growing membership, according to a new AM Best report.

The new Best’s Market Segment Report, titled, “U.S. Fraternals Face a Difficult Growth Environment,” said that the segment’s premium growth was relatively flat in 2018 and has been that way for most of the last decade. AM Best believes fraternal insurance companies must embrace newer technologies or risk falling behind.

Net premiums written (NPW) for the 44 U.S. life fraternal companies covered in this report have hovered around $10 billion in each of the past eight years. The fraternal population has tried to compete by guaranteeing higher minimum interest rates on its individual annuity business. But that elevates the fraternals’ risk profiles and pressures operating results.

Still, in 2018 the fraternal segment recorded an 85% increase in net income to $1.6 billion, allowing for consistent growth in the fraternal segment’s capital and surplus, the report said. The segment has extra capacity even though its financial flexibility tends to be limited.

Many fraternals also have broadened their target market to include more religious affiliations or demographic groups. If Millennials become even more socially-conscious and community-focused, the idealism of fraternals may appeal to them. The report notes that AM Best focuses on premium growth, as opposed to membership numbers, as a key component of operating performance.

Consolidation may be more difficult for fraternals, owing to their differing charters. Regarding technology, AM Best foresees that only the largest fraternal societies are likely to be first movers on innovation owing to their limited resources, especially as the insurance industry technology moves toward a world of data analytics and real-time health monitoring devices. Some organizations may enter into run-off, as they struggle to keep up.

© 2019 RIJ Publishing LLC. All rights reserved.

France reforms retirement

Posted on October 10, 2019 by -

This summer, France began shaking up its retirement savings system, enacting a new pension law and new regulations in an effort to make it easier for its citizens to save for retirement and to stimulate investment in the domestic economy, according to a report in IPE.com.

Natixis, BNP Paribas, Amundi are among the French asset managers who are launching products in the expanded defined contribution space.

On October 1, a new savings vehicle, called the Plan d’Epargne pour la Retraite, or PER, became available within defined contribution (DC) plans. PER comes in three flavors: PERin for individuals, and two group versions (universal PER and categorical PER), which companies can combine into a single plan.

All three variants enable participants to choose an annuity, a lump sum (but only from voluntary contributions), or a combination of the two when they retire.

Members have the option of withdrawing some of their own contributions prior to retirement to buy a primary home. The default investment option is based on “lifestyling,” it is now easier to change providers, and tax incentives on voluntary contributions have been standardized.

The new plans are expected to compete with traditional French savings products such as life insurance and bank savings accounts. Life insurance is seen in France as a liquid medium-term savings product. Pension products are less liquid, allowing an asset allocation consistent with a long-term horizon and giving better long-term performance. Life insurance is generally invested in guaranteed assets, and real returns are poor because of the current low interest rates.

“Pension products will be invested in lifecycle funds, with some rules fixed by law,” said Laure Delahousse of the French asset management association, AFG. “They will be allowed to invest broadly in stocks, the proportion of stocks decreasing when the retirement date approaches.

“The investment horizon will now be much longer than for some of the current products. This will clearly open the door to riskier assets such as listed equities, but also new frontier asset classes such as illiquid real assets like infrastructure,” said Estelle Castres, executive managing director, head of insurance channel and GKIC Group, Natixis Investment Managers (NIM).

“Besides focusing on real assets, we are also working with our affiliates and clients on ESG/energy transition products in the new PER or FRPS format. This therefore aligns the government mission of funding the real economy and ESG/climate change issues in the long term, along with retirement savings under the PACTE law,” she added.

“Default investments will include a manager-guided fund or target fund, or—as in current life insurance contracts—a general account (fonds euro) and unit-linked offer. For the PERin, savers will be able to transfer their current life insurance contract into the new PACTE law version with a tax incentive, and by 2022 those will be ring-fenced.”

Xavier Collot, director of employee savings and retirement at Amundi, said, “We expect providers to transform current products into PERs, to expand voluntary contribution opportunities and tax deductibility, and to equip companies that have no supplementary retirement plan. The reform also allows investment into new asset classes such as real estate and private equity in order to increase diversification and potentially increase yield.”

BNP Paribas also have products on the launchpad. The company has retooled its core lifecycle funds to fit with PACTE law requirements. It is also “reinforcing accumulation/decumulation strategies, making them greener and introducing innovative investment management solutions such as ‘isovolatility’ funds in collective schemes (which ensure that volatility remains at a certain level).”

The future marketplace in France for ‘fonds de retraite professionelle supplémentaire’ (FRPS)—supplementary pension funds—is relatively quiet.

The FRPS framework allows providers to manage both individual and occupational arrangements. Although Aviva France, Malakoff-Mederic and Sacra are planning new vehicles, other providers have not shown the same enthusiasm.

© 2019 RIJ Publishing LLC. All rights reserved.

The Pfau Phenomenon

Posted on October 10, 2019 by -

Wade Pfau’s arrival as a retirement income guru became clear to me during a presentation held long ago in the Merton Miller Forum at Dimensional Fund Advisors’s modernist headquarters on Bee Cave Road in the brown hills west of downtown Austin, Texas.

Pfau wasn’t present at that session (part of a Retirement Income Industry Association (RIIA) conference), which focused on BlackRock’s CoRI planning tool. But, during the Q&A period, one of the advisers in the room raised his hand and said to the speaker, “I hear you, but Pfau says…”

For me, that was Pfau’s tipping point. For others he may have arrived earlier. Armed with a Princeton Ph.D. in economics, Pfau, 42, has steadily gained respect over the last decade as an academic on whom advisers and annuity issuers can rely for firm evidence that the most efficient way to fund personal retirement is to blend investments and annuities.

His now-solid reputation is based on producing prize-winning articles for the Journal of Financial Planning and other adviser publications, directing The American College’s Retirement Income Certified Professional (RICP) program, and logging a lot of miles on the adviser conference circuit.

And, not least, by writing books on retirement income planning. Two years ago, the self-effacing Iowan self-published How Much Can I Spend in Retirement: A Guide to Investment-Based Retirement Income Strategies. He followed it with Reverse Mortgages: How to Use Reverse Mortgages to Secure Your Retirement.

[In the interest of full disclosure: Pfau’s books have been offered as premiums for new full-year subscribers to Retirement Income Journal.]

Safety-first

Now Pfau has published the book I’ve been waiting for: Safety-First Retirement Planning: An Integrated Approach to a Worry-Free Retirement. It pulls together everything advisers need to know about the various kinds of income-generating annuities and how they fit into a retirement income plan.

“Safety-first” retirement planning simply refers to a belief in funding all of one’s essential expenses in retirement—the core liabilities—with guaranteed sources of income like Social Security, pensions and, if those two don’t cover the essentials, with an annuity that produces guaranteed income for life. Excess savings can be invested in risky assets.

This idea is not new. In fact, during my stint in retirement product marketing, I asked my boss to summarize our official position on single-premium immediate annuities, and that’s essentially what he told me. It’s a concept that Pfau’s predecessors and peers—Zvi Bodie, Harold Evensky, Moshe Milevsky, Joe Tomlinson, Steve Vernon et alia—would not dispute, especially where “constrained” (i.e., strapped) retirees are concerned.

In fact, “safety-first” planning strongly resembles the “floor-and-upside” methodology behind the Retirement Management Analyst designation developed by Pfau, Michael Zwecher and others under the guidance of Francois Gadenne a decade ago at the (late, great) RIIA.

But Pfau, perhaps in part because of his Princeton stamp-of-approval, has arguably pierced mainstream independent advisers’ resistance to this general concept (and to annuities) to a degree that others have not. Most advisers, indeed, are still quite attached to the “4%” safe withdrawal rule (which is really a preserve-and-grow-principal philosophy that works best for high net worth retirees).

His diligent and thorough calculations, explanations, and Monte Carlo simulations give advisers—especially advisers unfamiliar with insurance products—the intellectual confidence they need to recommend annuities to clients entering retirement.

Advisers, it seems reasonable to say, are risk-takers, and the fear-driven risk-reduction aspect of annuities (not unlike the risk-reduction aspect of index investing years before) alienated them. His charts and graphs have shown that annuities are justifiable on the basis of greed and not just on fear.

More specifically, he has articulated the proposition that by replacing the bond allocation of a total return portfolio with income annuities, you can get higher yields than bonds, while allowing the retiree to take more risk with his or her equity allocation. The result is higher utility, as Pfau writes on page 277 of the new book:

“All income annuity participants, both the short-lived and long-lived, can enjoy a higher standard of living while they are alive than they would have otherwise felt comfortable with by taking equivalent amounts of distributions from their investments.”

© 2019 RIJ Publishing LLC. All rights reserved.

‘Safety First’ Income Plans, Per Wade Pfau

Posted on October 10, 2019 by -

Wade Pfau, Ph.D., who directs the Retirement Income Certified Professional (RICP) designation program at The American College, recently spoke with RIJ about his new book: ‘Safety-First Retirement Planning.” It’s a follow-up to his two previous self-published books, about investment-based retirement planning and reverse mortgages.

The new book explains the synergy that can be achieved—in terms of reduced risk and increased consumption in retirement—by more or less substituting income annuities (or the income benefits of deferred variable and indexed annuities) for the bond portion of a retirement portfolio. I asked Pfau which type of annuity vehicle he recommends for retirees. There is, of course, no black-or-white answer.

“Any form of risk-pooling is better than none,” Pfau told RIJ. “The starting point would be to look at the level of income you could get from a life-only SPIA (single-premium immediate annuity), and then compare it with the income from a variable annuity (VA) or a fixed index annuity (FIA).

Wade Pfau

“Then you have to ask if you’re willing to accept their lower level of starting guaranteed income [offered by VAs and FIAs], and whether their upside potential is enough to offset that. Psychologically, some people might be more comfortable with the deferred VA or FIA because they don’t want to give up liquidity.

“With the VA, too, if the product makes them feel more comfortable about investing in stocks, they might be more comfortable with the fees in those products.” (Note: All annuities have fees. But the fees of VAs are more explicit and visible than the fees of indexed and immediate annuities, most of which are reflected in the price or payout rate of the product.]

Even among those who have accepted annuities as part of a retirement income strategy, tactics are still widely debated. For instance, some advisers recommend a bucketing-like strategy that uses, perhaps, a guaranteed period-certain or life-contingent income annuity for the early years of retirement and keeps stocks simmering on the back burner (the better to control sequence risk, which involves the negative impact of a major downturn in stocks during the first five years of retirement on portfolio sustainability).

Others invert that strategy and recommend spending from an investment portfolio in the first five or 10 years of retirement and buying a deferred income annuity (DIA) that doesn’t start paying out until age 80 to 85 (the better to control longevity risk at the lowest cost).

What does Pfau think? First, he says, “I’m not a big fan of bucketing. It’s probability-based.” But if he had to choose between using guaranteed income products first or last, he would put them first.

“A reasonably strong case can be made for starting income right away,” he said, speaking by phone from an American College conference in San Diego. “While it’s true that the longer you wait, the harder it is to beat the yield of an annuity with other safe investments [because the mortality credits become a larger factor in the payout as the annuity cohort shrinks over time]. But even at age 65, the implied longevity yield of the annuity is already good enough. To beat it, you have to take more risk.

“So I’d put the insured income first and put stocks at the back end. Longevity insurance [another term for DIAs] is better than nothing, but if you buy longevity insurance and take income from an investment portfolio at the beginning of retirement, then you’re opening yourself up to sequence risk.

“Also, if you follow the strategy of combining of longevity insurance with a 20-year bond ladder, you will probably be selling stocks to buy the annuity. But you really should be selling bonds to buy the annuity. When you sell bonds to buy the annuity, then any level of partial annuitization should improve your long-term outcome.”

Many advisers say that immediate income annuities aren’t attractive at current interest rates. But Pfau doesn’t consider low rates a deal-breaker for SPIAs. On the contrary.

“For someone who has retired, the case for an income annuity actually becomes stronger with low interest rates,” Pfau said, “because mortality credits are not impacted by rates.” He also doesn’t believe that low rates are necessarily a signal that stock prices are destined to rise in the future.

Rather, he subscribes to the precept that if equity returns are equal to the risk-free rate plus an equity risk premium then, all else being equal, a lower real risk-free rate will presage lower equity returns.

To assume that equity returns will go higher when real interest rates go down forces you to assume that the equity risk premium will be higher in the future, he reasons. “So I’m not comfortable building that into my analysis,” Pfau said.

“The problem with bucketing strategies,” he added, “is that they don’t explain how [the transitions between buckets] should work. So you can end up creating more risk for the plan rather than less. Even if you use an automatic bond ladder where you have ten years of bonds and buy a new bond every year, you’re still creating interest rate risk.”

In addressing the question of which is better—a fixed or inflation-adjusted income annuity—he said, “I don’t think it’s necessary to build inflation protection into the annuities. For a lot of people, spending needs will decrease with age. Or they can revisit the question and make an additional purchase of annuity income.

“The other issue involves sequence risk. If you don’t buy the inflation-protection, a SPIA will cost less. That means you won’t need to withdraw as much from your liquid investments to cover your discretionary needs. The lower withdrawal rate compensates for the impact of inflation.”

I asked Pfau about the “annuity puzzle”: Why don’t more people who don’t have pensions buy them?

“Part of it can be explained by how the tax laws work in the US,” he said. “Under those laws, annuities became used as a tax deferral tool. Because of that, annuity and pension have evolved to mean two different things. Also, annuities are complicated,” he added. In the new book, he observes that Americans already have a lot of inflation-adjusted, joint-and-survivor annuitized wealth in the form of Social Security.

More importantly, “People think that annuities are too expensive in part because they have a hard time understanding how much they can spend from a given asset base. They’re not comparing [SPIA payouts, which are about 6% a year] to the level of spending that investments can support,” Pfau said.

He was referring to the fact that a 65-year-old can spend only about 4% a year from a balanced portfolio without fear of running out of money. Yet the 4% “safe withdrawal” rule remains the most popular retirement income-generating strategy among financial advisers.

© 2019 RIJ Publishing LLC. All rights reserved.